Country risk overview: ITALY

Italy plunged into recession

Italy went into recession in the second half of 2011, and has sunk deeper into it in the first quarter of 2012 as a result of the drop in household consumption, investment and exports. This drop reflects both rising unemployment (which affects 10% of the workforce), the tightening of access to credit, weak foreign demand and the collapse of confidence among economic agents. However, the more pronounced fall in imports than in exports is responsible for a positive contribution from foreign trade to growth. Except for agriculture, all the sectors experienced a fall, starting with construction. The deficit reduction plan for 2012 has not yet had an effect at the start of this year and the decline in industrial production does not yet take account of the two earthquakes that struck in May in the north of the country. This would suggest a further deterioration in the second quarter and a recession of about 1.8%

for the entire year. However, the weakening of economic activity should help reduce the current account deficit. Furthermore, fuelled earlier this year by the rise in commodity prices, inflation should ease as a result of weak domestic demand and lower prices of staple products.

Massive public debt

Investors are today coming to terms with the scale of public debt, in large part inherited from the large deficits recorded until the middle of the nineties. This debt reached 120% of GDP at the end of 2011, the highest level in the eurozone after that of Greece and the biggest of all in absolute value.

Despite a fairly prudent fiscal policy in recent years, the consolidation effort had to be intensified under pressure from the markets and the ECB. The size of government's financial needs and the economy's weak growth potential, in the current context of increasing uncertainties within the

eurozone, have further eroded market confidence. Long-term interest rates are again hovering around 6%. Doubts about the ability of the country to pursue reforms are even about to resurface in view of the fall in popularity of the Italian Prime Minister. Moreover, in the context of the crisis of confidence on the

interbank market, ECB loans have provided banks with liquidity and, until recent months, no sign of deposit outflows has been recorded. But banks are undermined on the stock market due to the tension in the Italian ten-year rates.

Companies weakened by the recession

Italy is going through a difficult phase and the financial situation of businesses reflects this. Bankruptcies continued to increase in 2011 as well as payment failures recorded by Coface. Among the reasons for this situation are the structural weakness of SMEs, which represent the bulk of the Italian industrial fabric, as well as the growing difficulties linked to access to bank lines of credit and the lengthening of payment periods in the public sector. Among the sectors most affected are construction and electrical equipment,

as well as the textile sector, which has always been structurally weak. On the other hand, the luxury goods sector, driven by demand from emerging countries, is doing rather well. The austerity measures adopted by the government have led to a sharp contraction in consumption, affecting all sectors of the economy, in particular large retailers (except for food discounters) and automobiles.

Strengths

· Strong tourism potential

· Still important role of industry

· Improved product range and highly profitable niches

(luxury clothing, household appliances, foodstuffs, machinery)

· Low household debt and strong saving capacity

· Government debt predominantly held by residents

Weaknesses

· High national debt, tax evasion

· Loss of export market share

· Low productivity

· Inadequacy of research and higher education

· Government inefficiency, large number of civil servants

· Banking sector weakened by exposure to Italy’s sovereign debt

· Backwardness of the south

(Source: Country risk overview, The Coface economic publications)